VIEWPOINTS OF A COMMODITY TRADER

Likeness to the truth is not the same thing as truth – SOCRATES 

 

A set of statistics that suggest a positive expectation (a system) is quite helpful when sailing the seas of uncertainty. In fact I believe most traders need a definitive plan to assure discipline. 

We need to look at the various measurements of risk and reward. We look at average winners, average losers, returns and draw-downs. We examine the numbers further to calculate Kelly Expectations (bet size), MAR Ratios and Monte Carlo distributions.

These are the tools that help us understand the system. On the other hand no matter how many numbers we crunch we cannot replace randomness with systematic probability. We can not quantify the future.  

Socrates once said that “likeness to the truth is not the same thing as truth.” Truth to the Greeks was basically law, something that had to be proved. All the back-testing in the world does not prove anything. 

These past statistics do not remove future randomness. At best they will give us some likeness to the back-test (or what we think is the truth) and we must manage the risk to make sure we are on that path. 

What is potentially more dangerous than the information which makes up the numbers, is how we feel about the accuracy of the numbers. In the real world, randomness plays a much stronger role than we would care to believe. Arrogance about potential accuracy can lead us to overestimate what we think we know and underestimate future randomness. This is how you blow up. 

The markets are constantly changing. There are new markets available to trade. Markets dry up in liquidity. There are shifts in volatility and correlation. Sometimes a combination of these things can happen at the same time. A system without a risk management component will not be able to properly identify these changes and unfortunately most vendors have not built any risk management into the equation. I think that is potentially dangerous. 

When you choose a number of these systems you will still be faced with how they will interact with each other. You have the risk of volatility and correlation shifts in the markets that you will be trading but you will also have the risk of correlation between the systems. 

This is what destroys most approaches, not the systems, but the way the systems were managed. A system that holds up in a rigorous back-test is at best “The One-Eyed King.” An approach that can see, but does not see everything we would like it to see. The good news is if we are aware of that fact we will be forced to manage that fact. 

I strongly believe we need a platform to monitor what is going on when we are in trades. The volatility of a market upon entry can be quite different than the volatility of that market one week or one month later. This holds true of correlation between markets, as well as correlation between systems.

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Filed under: Money Management, Trading Methods, Trading Psychology by Charles Maley